The Marzetti Company (MZTI) Q4 2016 Earnings Report, Transcript and Summary

Good morning. My name is Shawn and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Lancaster Colony Corporation Fiscal Year 2016 Fourth Quarter Conference Call. Conducting today's call will be Jay Gerlach, Lancaster Colony's Chairman and CEO; David Ciesinski, President and COO; and Doug Fell, Vice President, Treasurer, and CFO. [Operator Instructions] Thank you. And now to begin the conference call, here is Mr. Dale Ganobsik, Director of Investor Relations for Lancaster Colony Corporation.

Thank you, Shawn. Good morning, everyone, and thank you for joining us today for Lancaster Colony's fiscal 2016 fourth quarter conference call. Let me begin by reminding everyone that our discussion this morning may include forward-looking statements, which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially and the company undertakes no obligation to update these statements based upon subsequent events. A detailed discussion of these risks and uncertainties is contained in the company's filings with the SEC. Also note that an audio replay of today’s call will be available at our website, lancastercolony.com, later this afternoon. With that said, I'll now turn the call over to Lancaster Colony's Chairman and CEO, Jay Gerlach. Jay?

Thanks Dale and good morning and thank you for being with us today as we review our fourth quarter and fiscal year 2016 results. Dough and I will provide comments on the quarter, year and outlook for fiscal 2017 with Dave joining us to respond to your questions. Fourth quarter net sales increased 2.4% to $284.5 million and earnings per share reached $1.12 versus $0.93 last year. Sales growth was driven primarily by volume and pricing within our retail channel. Olive Garden brand shelf-stable salad dressings, croutons, and our frozen breads and Pasta all contributed to our retail sales growth. We were pleased to see the growth in our frozen brands with effective consumer promotion in somewhat easier comparisons to last year as the growth drivers. Food service channel sales were flat for the quarter and were impacted by pricing coming back closer to normal, after the impact of unusually high egg cost from earlier in the fiscal year. Our customer rationalization effort was also felt with greater degree this quarter and we saw less limited time offer promotional activity versus a very active quarter or year ago. Retail sales mix for the quarter grew 140 basis points to 51.1%. Segment operating margin improved 230 basis points to 17.5%, largely due to improved sales mix, favorable ingredient cost, and lower freight cost plus a better favorable pricing. Our consumer and trade spend was up in the quarter, including some increased product placement cost to support the introduction of our New York bakery Bake & Break garlic bread. While still early, we have been placed with the initial acceptance of this new product. For the full year, we were pleased to report a record in next net sales of nearly $1.2 million, net income of nearly $122 million, and earnings per share of $4.44. Net sales increased 7.8%, including the benefit of Flatout acquisition and 5.3%, excluding it. Volume, the Flatout acquisition and pricing were all contributors to sales growth. Retail sales mix for the year grew to 52%, up 80 basis points from last year. Retail channel sales were held by continued growth in our Olive Garden brand shelf-stable salad dressings, our Marzetti and Simply Dressed refrigerated dressings and croutons. Food service channel business was largely driven by growth in our international chain account business. For the full-year, segment operating margin improved about 140 basis points to 16.5% with volume growth and pricing along with lower input and freight cost, the key contributors. Looking at retail sell-through data from IRI for 52 weeks ending July 10, 2016, we maintained our leadership position in all six of our key categories, our fastest growing category, refrigerated dressings our Marzetti and Simply Dressed brands showed good sell-through growth although they have given up a little share as new entrants in more competitive activity have developed in that space. We picked up share in frozen garlic bread, croutons and flat breads, while losing a point of share in frozen dinner rolls. With that, I'd like to ask Doug to make some comments on the balance sheet and related items.

Thank you, Jay. Overall, our balance sheet continues to remain strong and not much has changed since our last earnings call. I will comment on some of the larger line items within our balance sheet that have changed since last year. As conveyed in our previous earnings calls, the decline in our cash balances is primarily driven by the payment of our $5 per share special dividend on December 31. From a high-level perspective, the decline in our cash balance of approximately $64 million since last year can be summarized as follows. Cash provided by operating activities of $143 million offset by regular and special dividends of $190 million and property additions of $17 million. In general, the increase in our accounts receivable balance reflects higher sales volume. Consistent with past quarters, we continue to see our overall ageings remain solid. Our inventories remain in line with our expectations and we continue to place emphasis on this important element of our working capital. As mentioned above, the cash expenditures for property additions totaled $17 million in fiscal 2016 with the largest amount spent on new packaging equipment to accommodate growth and plant improvement projects to enhance productivity. At the present time, we anticipate capital expenditures to be in the range of $20 to $22 million for fiscal 2017 and will include projects to increase capacity and productivity. Depreciation expense totaled $20 million for fiscal 2016 and we expect a similar amount for fiscal 2017. With respect to our balance sheet capitalization, we continue to have no debt and nearly $514 million in total shareholders’ equity. We ended the quarter with $118 million in cash and equivalents and we have available borrowing capacity under our credit facility of nearly $150 million. Given our balance sheet posture and overall liquidity, we continue to possess considerable flexibility to address our foreseeable cash requirements including the support of future organic growth initiatives, acquisition opportunities, continued dividends and opportunistic share repurchases. Finally, our overall effective tax rate of approximately 34% for the fourth quarter in fiscal 2016 is consistent with our expectations and previous guidance. We would expect a similar effective rate in fiscal 2017. Thanks again for your participation with us this morning and I will now turn the call back over to Jay for our concluding comments. Jay?

Thanks, Doug. We enter fiscal 2017 optimistic about our business, but with two major sales growth challenges both in our food service channel. Our customer rationalization process will impact sales negatively and price deflation will have a smaller, but still meaningful impact. Sales growth should not however unfavorably affect profitability as the rationalization plan should improve efficiencies in our dressing and sauce operation and deflationary pricing has pass through of reduced ingredient costs. On the plus side, for sales, we look for continued strength in Marzetti and Simply Dressed refrigerated salad dressings in our brands of croutons and improving Flatout and New York Bakery frozen garlic bread sales volumes. Olive Garden dressing should also show further growth. New products such as our New York Bakery Bake & Break bread, Marzetti Vineyard Dressings and just introduced Sister Schubert's shareable bread are also expected to go contribute to retail channel grow. We also feel our core national chain restaurant business should continue to grow absent the business we rationalized. We expect increased consumer and trade spending to support new products in general growth and distribution initiatives. Our supply chain will continue to be an area of focus and opportunity with both customer service and cost reductions a priority. Improving our operating efficiencies is an everyday goal across our business. We expect lower ingredient cost driven by much lower egg cost versus the unusual spike experienced last year. Other ingredients are expected to be generally favorable in the first half of our fiscal year than trending to flat in the second half. Bread costs are anticipated to remain at lower levels although we likely will be lapping those as year progresses. We continue to be interested in acquisition growth and are focused on branded retail product lines that are on trend with the consumer and likely merchandised in the perimeter of the store. With our longtime presence in the produce department and more recent movement into deli with the Flatout acquisition and particularly like those areas of the store. We appreciate your interest and thank you for joining us this morning. Sean, we’re happy to take questions at this time.

[Operator Instructions] Your first question comes from Frank Camma with Sidoti. Your line is now open.

Good morning, guys. How you doing?

Hello, Frank. Good morning.

Good morning.

Good morning.

Hey, can you talk a little bit about – so just – you lead on there a little bit with the competitive landscape in, I think, there was two categories where maybe the share slipped a little bit. Can you just talk a little bit more about that? Was it driven by new products or product innovation or was it totally new brands coming into the market?

In the refrigerated dressing space, it's a combination of some new players that have been getting a little bit of shelf space and in general a little bit more competitive promotional activity. The frozen dinner rolls, in that case, no new entrants, I think just a little bit of again competitive activity, not a significant shift there when you think about the fact we've got about a 50% share in category.

Okay. Obviously, you had a lot of success with some of the new flavors in the salad dressing. Do you feel that your competitors may be mimicking that activity? I was just wondering if you can comment there.

Well, I think we're seeing a variety of things both flavors as well as specific ingredients. The competitors are using maybe a little different than what we are using and others are using. So things like yogurt and Greek yogurt are definitely finding a presence in the refrigerated dressing space today.

Okay. And just a little more commentary on the deflation on the retail side. Is it fair to say that you might feel more pressure in certain categories than others, for example, like frozen verses the refrigerated dressings or is that not an accurate statement?

Frank, we're really not seen true deflation in the retail side, we might see again a little bit more promotional activity in that that you could categorize as that. But the real deflation we're talking about is over on the food service channel.

Okay, okay. Understood that. Okay. And the last thing I know you can't talk anything about specific acquisitions or anything, but can you – is there any way for you to talk about sort of just over the last – from your experience over the last couple years, has the flow of deals changed at all, credit markets are a little more uneasy than where they were perhaps a couple of years ago. I was wondering if that changed anything or if more sellers have come out because of pricing, I was just wondering if you can comment on that.

Frank, I don't think we've really seen a noticeable change in overall deal flow at this point.

Okay. Fair enough. Thanks guys.

You are welcome.

Thank you.

Thank you.

Your next question comes from Eric Gottlieb, D.A. Davidson. Your line is now open.

Yes, thanks for taking my questions.

You are welcome.

I'm wondering the push back that you’re seeing from customers, is there any particular categories where they are basically pushing back on pricing for inflationary cost?

I again, Eric, on the retail channel, I don't think we’re seeing any particular push back from customers. And frankly on the food service side, it's not push back from customers, it is our pricing into that channel which is more cost driven. And so, it is traditionally is ingredient costs – key ingredient costs anyhow that moved up and down. At different points in time, we have passed those changes on with either increased or decreased pricing, so this past fiscal year we had inflationary pricing driven by this sharp spike in egg cost, we started seeing in the spring of 2015 and then those prices – egg prices have been coming down. So far this calendar year, back to pretty much historical levels and our pricing is now reflecting those lower costs.

During – when egg prices were high, we heard that some of your competitors were reformulating or adding egg substitutes. Were you doing that at all? Have you changed formulations?

We did a little bit of that where we could, I wouldn't tell you it was significant, but we did make some minor adjustments, if it was feasible without changing either the quality or the taste of the product.

Okay. And then can you detail your hedging strategy, again, oil, I know eggs you can’t, but how far forward are you bought on certain ingredients.

Eric, this is Doug. For the oil, we are through that forward buying strategy, I think we’ve conveyed you in the past. We laddered that out over a 12-plus month period. For the first half of fiscal 2017, we are largely covered. And then we have some level of coverage into the first half or the second half of 2017 and just a little bit beyond.

Okay.

We do the same sort of routine with flour. And we have pretty much all of our coverage in for the first half of 2017 and some coverage again into the back half of fiscal 2017.

Got it. And then this for Dave. So last quarter, it was day 8, I guess – around day 115, I think, something…

I think you got somebody else's account, everybody is counting.

So I'm wondering, you know, have your views – what's your views on company direction and strategy, what job number one is, what keeps you up at night, basically a state of the union address if you will on what you are seeing at Lancaster?

What I would tell after having spend a good quarter now unpacking the business and getting to know the people and customers, a solid track record of success underpinned by very, very strong brands. Great innovation, a strong presence in growing in relevant categories particularly in the perimeter of the store, if you look at where we're positioned versus a lot of the bigger traditional the large cap and mega cap players. I like where we play in the store. And we've been able to deliver that by good solid innovation. The food service business is also very, very well positioned with great brands, great innovation and we partner with some of the best customers that are in the industry. Food service is a big industry with some that are growing and some that aren't. And I like the fact that we seem to have been able to leverage our capabilities to partner with the ones that are the most consumer relevant and have demonstrated the most consistent growth. So, I am sitting here at day 115, even more excited than I was at day 8. As we look forward, the areas that we want to focus on are probably as follows. Figure out how we can accelerate our ability to drive base growth through innovation. So this isn't a new skill set, but it's going to take an existing skill set and just build more muscle against. The other is as we look at our supply chain operations, figure out how we can make smart choices to drive consistent and modest margin accretion into our business, would make a little bit more out of every dollar that we sell. And then, finally, number 3, as Jay pointed out, we have a strong presence in the produce section of the store, which is arguably some of the most exciting real estate in retail today. And with the Flatout acquisition, we have a presence in that exciting and highly fragmented branded specialty bakery and deli section. And as we go forward, it's figuring out those niche bolt-on acquisitions that complement our existing capabilities and we use those to just accelerate our growth going forward. So, short question, medium answer for you, but that gives you a taste of maybe where we're focusing going for.

Got it. Thank you for the color. With that, I will pass it on.

And your next question comes from the line of Phil Terpolilli from Wedbush Securities. Your line is now open.

Hi guys thanks for taking my call. This is actually Dominic Ruccella on for Phil. Just kind of starting off, I want to revisit Eric's question, it sounded like you mentioned that the costs are being passed along, so does that mean that the pricing step up we saw in 4Q, we saw it come through a little bit last quarter is going to be - is not going to be continued into the first half of 2017, am I thinking about that the right way?

Yes you are. It relates to the retail channel of our business, which is where a lot of that pricing was last year and where the deflation is happening as we've moved into this year. There was a little bit of retail pricing that was driven by increased ingredient cost, primarily eggs. Traditionally those prices are not adjusted as ingredient cost change if they change downward.

I think, Jay if I may add, what I would just clarify for you folks is that on the food service side they are contractual, so they have escalators when the commodities go up, and de-escalators when the commodities go down. That impact the revenue line and what you're seeing is the impact isolated within the food service part of the business where those de-escalators are taking effect and then on a going basis they roll forward, but it isn't impacting the retail part of the business, there when you take a price increase, unless you are something extraordinary that price increase dips going forward.

Got you. Very helpful, thank you. And I guess just sticking on the revenue side, food service was flat, could you break out how much of this you are seeing from rationalization versus the limited time offer reductions?

Not in any real specifics Dominic, but the bigger part is, I think on the rationalization side and to a lesser degree, but still noticeable on the less promotional activity. Pricing would be in between.

Got you, okay. That helps. And then just the last one I have is, as we think about total operating margins, obviously we’ve seen some good expansion, do we think you guys expect that that can continue into fiscal 2017 and throughout or is there some point in the future where we will start to see that operating margin level off.

Well that’s certainly a goal of ours as is either Dave and I have commented on some of the different components between supply chain improved operating efficiencies. The mix change perhaps as we see the retail channel of business growing a bit faster than the food service channel. Those kind of things should all contribute, we hope to marginal opportunity.

Great, understood. Thank you for the color and I will pass it along. Thank you.

You're welcome.

Thank you.

[Operator Instructions] Your next question comes from Elliott Schlang with Great Lakes Review. Your line is now open.

Good morning Jay and Doug and congratulations on another good quarter.

Thank you Elliot, very good morning

A few questions if I may, I will be interested in what if any plans you have for a further geographic expansion or emphasis in any particular area?

Elliott on the one hand we continue to pursue some opportunities in geographic areas where we have don't have big presence, particularly moving west including California. So, there is effort going on there, I wouldn't say it’s real unusual effort, but it is there and we are pursuing that. At the same time, we are also being sure we are active and pushing to grow our presence in our core markets, which vary between our different brands, but we’re very focused on those as well.

And any new thoughts on Canada or Mexico?

Well Canada has been a good market for us for a number of years. We continue to look for further opportunities there both with expanded distribution of existing products and moving additional products into the market. Mexico is a much smaller market for us and not getting real high priority at this point, but we are doing some business there and we will look for opportunities there.

And on the cash that you alluded to, I assume that’s invested in places similar to what you've done historically, you are not taking any - you might comment on where that cash is invested? In what types of vehicles.

Yes, it is being invested consistent with past practices and it is largely in commercial paper US government securities very, very secure type investments.

And given the limited acquisitions that you had in the last few years, are you considering broadening your acquisition criteria at all or pretty much sticking with the tried and true formula?

Elliott no, I don't think we are looking to broaden it. If anything we are bringing a little bit more focus in what we are looking for is we touched on some of the core areas in store we are interested in and particularly the parameter of the store. So, if anything you probably see a little bit more focused, rather than a broader look from us.

And any newer lost accounts that we should be aware of and that you are free to talk about and especially any comment on the Walmart relationship with the challenges that's Walmart’s had recently.

No Elliott, no changes with the exception of back on what we've done from a rationalization standpoint in our foodservice channel. Other than that no noticeable additions or deletions, our business continues to perform well with Walmart and we are glad to see their performance improving.

And I assume from the number of shares outstanding that you did not purchase in the quarter any comment about your program for the future in the corporate repurchase side?

That's correct Elliott, we didn't repurchase any. As you know, we keep shares authorized, but do that on an opportunistic basis and just haven't had that as our top priority at this point, but always have an open mind to that and keep an eye on any developments that might suggest activity there, but nothing in the fourth quarter and virtually no shares for the fiscal year.

And as far as the labor contracts, anything coming up of any significance in the next several months?

Actually, we are in the midst of negotiations in our frozen garlic bread operations outside of Cleveland as we speak.

And that’s due when?

We are actually past due, so we've continued to operate, the workforce continue to work as negotiations proceed.

Good luck on that, and congratulations again on the good quarter. Thank you.

You're welcome. Thank you.

Thank you.

And there are no further questions at this time. I will turn the conference back to Mr. Gerlach for any concluding remarks.

Well thank you all for joining us today, we look forward to talking to you later in October with our first quarter results.

And this concludes today's conference. You may now disconnect.